Direct funds – What are direct funds & Differences between a regular plan and direct plan.

As per the directions of the Securities and Exchange Board of India (SEBI), a mutual fund offered by an asset management company (AMC) comes in two variants and they are regular funds and direct funds.

What are direct funds?

Direct funds are those mutual fund schemes that are directly offered by the fund house or AMC. The names of these funds are prefixed by the word ‘direct’. There is no involvement of a third party, distributor, or agent. The investors directly deal with the AMC offering the fund. Since there is no involvement of a third party, there are no commissions or brokerage charges involved in these transactions. Hence, the expense ratio of direct plans is comparatively lower than that of regular funds.

Features of direct funds

The following are the salient features of direct funds:

• Investors don’t depend on a third party to make investments.
• You can invest in direct funds, both online and offline.
• As there is no commission to be paid, the fund house will not impose the distributor fee and hence, keeping the expense ratio on the lower side.
• Transaction charges are not levied.
• The word ‘direct’ denotes the direct funds.

Best direct fund

The best direct mutual fund would have the following characteristics:

• Has offered good returns over a long period.
• Is often not affected much by the market fluctuations.
• The expense ratio is lower when compared to peer funds.
• Offers diversification of the portfolio.
• The fund manager has an excellent track record.

What are regular funds?

Regular funds are those mutual fund schemes that are sold through agents and distributors. Since investors don’t deal directly with the fund house, there are commissions or brokerage charges involved in regular funds. Investors don’t pay the commission directly to the agent. Instead, the fund house collects it through the expense ratio and pays the agent or distributor. Therefore, the expense ratio of regular funds is slightly higher than that of direct funds.

Differences between a regular plan and direct plan in mutual funds

The asset allocation and fund manager(s) would be the same for regular and direct mutual funds offered by a fund house. The only way these funds differ is by the commissions or brokerages. The following table shows the major differences between regular and direct funds:  

Advantages of investing in direct funds

Following are the significant benefits of investing in direct funds:

1. Low Expense Ratio: Since there is no third party between you and the AMC, the expense ratio of these funds would be relatively lower than that of the regular funds. In regular MFs, the AMCs pay the agents a commission and recover the same through the expense ratio.
2. Higher NAV: The Net Asset Value (NAV) of a mutual fund is calculated by dividing the overall value of the total assets in the fund’s portfolio by the number of outstanding units. Since there are no brokerage charges, the NAV of these funds would be relatively higher than that of the regular funds.
3. High Returns: As there is no brokerage in the case of direct funds, the expense ratio of direct funds would be comparatively lower than that of regular funds. The difference in the returns between the regular and direct funds might look negligible, but it would be massive if you stay invested for a long-term. Here’s an example: Let’s assume that you invest Rs 12,000 a month in SIP for eight years in both regular and direct plans offered by an AMC. Let’s consider that the returns provided by the direct and regular funds are 11% and 10% respectively. In the case of regular funds, the AMC pays a brokerage of 1% to the third party. The following table depicts the corpus accumulated at the time you redeem your units:  

   Parameter	Direct Fund	Regular Fund	Difference
   Monthly SIP amount	Rs 12,000	Rs 12,000	0
   Investment Tenure	8 years	8 years	0
   Returns	12%	11%	1%
   Amount accumulated at the time of redemption	Rs 19.19 lakh	Rs 18.34 lakh	Rs 0.85 lakh

4. No Conflict of Interest: As you directly deal with the fund house, you alleviate the risk of being misled by a third party. An agent or a distributor may make you invest in particular mutual fund schemes for their interest. Hence, opting to invest in direct funds will avoid the conflict of interest scenario.

FAQs (Frequently asked Questions)

As a tax-paying citizen, the Section-80c of the Indian Tax Act allows you some breather –
a deduction of up to 150,000 from your total annual income.

Which are the best mutual funds to invest in India?

You may consider picking the best mutual fund depending on your investment objectives and risk tolerance. You could check the track record of the mutual fund house and the fund manager before investing in the mutual fund. However, you may invest in the mutual fund only if you are comfortable with the investment style of the fund manager.

You must check the expense ratio before putting your money in the mutual fund. You may find the best mutual funds having a lower expense ratio. However, you must check other important parameters before investing in the mutual fund. You would find the best mutual funds have a lower turnover ratio for the portfolio. You may avoid mutual funds where the fund manager churns the portfolio many times.

You may pick the best mutual funds depending on your investment horizon. You could invest in equity funds only if you have an investment horizon of three years or more. You may invest in debt funds for a shorter time horizon of under three years. Invest in balanced or hybrid funds only if you have an investment horizon of three to five years.

You may measure the performance of mutual funds against a benchmark index to select the best mutual funds. For example, you may check the performance of a large-cap fund against the Nifty 50. Compare the performance of the mutual fund against its peers and also take a look at the consistency of performance. Best mutual funds have a consistent track record of outperforming peers and the benchmark index over five years or more.

You must choose the best mutual fund house with large assets under management (AUM). The fund house may be able to bear sudden redemption pressure if it has large assets under management.

How to find the best performing mutual funds in India?

Best performing equity fund:
An equity mutual fund may be the best performer in its category if it consistently beats the benchmark index over some time. The best performing equity fund has a lower expense ratio as compared to peers. You may find the best performing mutual funds doing well across market cycles.

You must check the alpha of the equity fund to identify the best performing mutual fund. It shows the excess return generated by the equity fund above the benchmark index. You can pick the equity fund with a high alpha as compared to the peers.

You must take a look at the beta of the equity fund. It gives you an idea of the volatility of the fund as compared to the benchmark index. An equity fund with a beta less than one is less volatile as compared to a fund with a beta more than one.

Take a look at standard deviation which gives you an idea of the volatility of the equity fund. You may find an equity fund with a higher standard deviation to be riskier as compared to a fund with lower standard deviation. You may pick the best performing equity fund based on risk-adjusted returns. Check the Sharpe’s ratio of the equity fund and opt for an equity mutual fund scheme with a higher Sharpe’s ratio which signifies a higher risk-adjusted return.

Best performing debt fund:
You may consider picking the best debt funds based on the credit quality of the bonds in the portfolio. Credit rating agencies would assign a credit rating to bond-issuers based on their ability to repay the principal and interest amounts. You must invest in debt funds with AAA-rated bonds in the portfolio.

It is a safer investment as compared to bonds of a lower rating which may offer a higher interest rate. However, they could default on both principal and interest payments.

You may select the best performing debt fund based on the expense ratio. You must not pick a debt fund with a high expense ratio. Best debt funds have an excellent track record of performance over three to five years. You may select the best debt fund where the average maturity period matches your investment horizon.

Best performing hybrid fund:
You could pick the best performing hybrid fund with a good track record of performance over three to five years. Select a hybrid fund which has beaten the benchmark index and peers over some time.

You may check the track record of the fund house and the investment style of the fund manager before picking the best performing hybrid fund. Pick a fund house with huge assets under management which can bear the sudden redemption pressure of big investors.

Select the best performing hybrid fund with a low expense ratio. A high expense ratio may eat up the return from the fund. The best performing hybrid funds must match your investment objectives and risk tolerance. Take a look at the portfolio of conservative hybrid funds. It gives you an idea on the credit quality of bonds in the portfolio.

Which is the best way to buy mutual funds in India? You may buy mutual funds through cleartax invest. Follow these steps to invest in mutual funds.

• You must log on to cleartax invest
• You then select the mutual fund house from the list of fund houses
• Select the mutual fund scheme based on your investment objectives and risk tolerance and click on Invest now
• You must select the amount you plan to invest in the mutual fund scheme and the mode as either One Time or Monthly SIP.
• You must fill up the requisite details such as name, email ID, mobile number and complete the transaction.

Complete your KYC (Know Your Customer) before investing in a mutual fund scheme. You must visit the website of a KRA (KYC Registration Agency) and create your account. You will have to fill the KYC registration form with details such as your name, email ID, mobile number and so on.

Upload copies of your self-attested identity proof such as PAN Card and address proof such as passport, driving license or Voter ID along with a passport size photograph at the KYC Registration Agency. You may complete the IPV (In-Person Verification) through a video call to verify your documents against the originals and also your signature.